Which STI Policy Aftermath of Economic and Financial Crisis?
Investment in Knowledge-based Capital (KBC) as a Response?

Dominique GUELLEC

The current economic crisis, which started at the end of 2008, affects almost all of the countries in the world. This presentation will focus on science, technology, and industry (STI) policies in the aftermath of this crisis, and will be broken into four parts. The first part will focus on innovation and the macro economy. The second part will cover innovation in the current crisis. Next, the responses of policies will be discussed. Finally, the outlook for innovation in the near future will be introduced.

When thinking of innovation in the context of the macro economy and current crisis, we have to start with the three major features which characterize this. The first of which is the weak financial system. The financial system has been partly, but not completely, repaired. Another feature is the downturn in economic activity and weaker demand. Finally, the most recent step in this crisis has been characterized by the high levels of sovereign debt which created government budget deficits and difficulties in financing them in a number of countries.

With regard to these conditions, several positive and negative expectations could be held about innovation. Even though the state of the macro economy is not good, reduced demand for products could have a direct impact on competition. It may result in smaller markets which, in turn, could lead to more intense competition between companies in order to keep or expand their market share. Innovation is one of the competitive weapons used in companies, thus it may increase in response to reduced product demand. Another positive expectation for innovation could be that of resource reallocation. Reduced demand could lead to the necessity of producing cheaper goods, which usually requires some form of innovation for processing. Finally, the importance of innovation in terms of its value in providing a way out of the economic crisis is recently being recognized by the public and governments, which could have a positive effect on the public budgetary situation.

Negative expectations could also be held on the impact of the economic crisis on innovation. Less demand could lead to less revenue, which could have a negative effect on innovation as many companies finance innovation-related research and development (R&D) through revenue. Another negative expectation is that as consumers have less money to spend than prior to the economic crisis, they may refrain from purchasing more innovative products which tend to cost more than existing ones. Reduced liquidity and more uncertainty caused by the economic crisis can also be seen as having a negative effect on innovation, as investments are less likely to be made in companies under uncertain conditions, which would in turn have a negative effect on budget for innovation. A final negative expectation is the current public budgetary situation not allowing for governments to spend large amounts of money on innovation.

Research conducted on innovation in the crisis and beyond has resulted in five conclusions. The first is that the economic crisis that started in 2008 has negatively affected business innovation along with R&D in all countries. In 2009, indicators of business enterprise research and development (BERD) all decreased sharply. Second, although there has been a recovery of R&D to a certain extent, this has been very uneven across countries, industries, and types of firm. Third, large multinational firms in particular have recovered in terms of R&D to a greater extent than smaller firms. This is especially true in high-tech industries in Asian countries. Fourth, innovation in small firms, venture capitals, and new companies has been affected to the largest extent by the economic crisis, and has not yet recovered. Finally, the fifth conclusion was that the crisis had revealed and amplified strengths and weaknesses which pre-existed across countries, sectors, and firms.

In terms of numbers, the yearly growth rate of BERD in Japan, the United States, and the EU-15 combined shows a higher growth rate in 2010 than in 2009. However, the actual growth rate in 2010 was between 0%-1% and far below that of 2008. Patent filing data supplied by the World Intellectual Property Organization (WIPO) shows that growth rates were significantly hit by the crisis and dropped to a low point in 2009, yet recovered by the end of 2011. However, in 2012, the growth rates have started to drop again, which shows that recovery has been fragile. In terms of numbers expressing the recovery the growth of large firms, both R&D investments along with net sales of top EU and U.S. R&D investors were extremely negative in 2009, although they were very strong in 2010. Growth recovery in large firms has been significantly greater than the aggregate values. Other figures indicate that R&D growth in high-tech industries has shown positive signs of recovery relative to those of medium-tech and low-tech industries.

In relation to entrepreneurship, the number of new businesses created has not shown significant signs of recovery from the economic crisis, with the exception of those in Australia. In contrast, the number of bankruptcies has significantly increased in most countries. In some countries, the number of bankruptcies has decreased since the onset of the current economic crisis, although this is probably due to the fact that fewer new businesses have been created in recent years. Venture capital investment has partially recovered in the United States, where numbers hit a low point in 2009 and have been gradually recovering since then. However, current numbers in 2012 are still less than what they were in 2008. With regard to the difference between yearly growth rates of business-funded R&D between countries, China and Korea have been significantly less affected than the total OECD area as a whole. As an example, in 2009, China showed a positive growth rate of business-funded R&D as opposed to negative values for the OECD area as a whole.

Policy reactions to the crisis have been strong in terms of recovery plans in most countries. Recovery plans in 2009 gave a significant share of resources and expenses to science and technology, as well as innovation-related expenses. Governments are now aware of the importance of such fields for economic growth, and their use of resources has shown this. In Japan alone, $9 billion was devoted to science, technology, and innovation in the 2009 recovery plans. A number of measures were taken in order to implement those plans such as funding public research organizations in order to accelerate ongoing projects, distributing loan guarantees to small and medium-sized enterprises (SMEs), and providing tax breaks for businesses performing R&D. Furthermore, the percentage of GDP given by governments to support business R&D between 2005 and 2010 has increased in most OECD countries. Interestingly, Japan has actually been an exception in this regard. Whereas most countries have been putting more funding into R&D in the form of tax credits and indirect support, Japan actually reduced its R&D tax credit support over the same period of time.

Looking at the long-term perspective and outlook for R&D in the coming years, there are a number of factors which suggest risk for innovation-based growth in OECD economies. The first effect of the economic crisis is damage to human capital through long-term unemployment. In other words, unemployment leads to a depletion of available skills for innovation. Another effect is that of damage to investment. A number of investment projects in the business sector were postponed, which should have a negative effect on the future rate of innovations. A third risk factor to consider is the relocation of innovation activities to emerging countries. This trend has been observed even prior to the economic crisis, and it is possible that this will be accelerated as a result of the current crisis. Other factors also include financial market conditions and public support for innovation. In recent years, there has been an increase in support for innovation, though changes in budgetary policies have resulted in more of a tendency toward evaluation and targeting of public expenditure. This may also be considered a long-term risk for innovation-based growth.

In conclusion, both constructive and negative forces affecting innovation and public support to innovation in the future are expected. Although it is most likely that conditions will be unfavorable from macroeconomic and budgetary perspectives, there are a number of positive signs for innovation in the future. Innovation keeps a distinctive competitive factor in a globalized economy, and it appears that both high-tech companies and governments are aware of this and are continuing to invest financial resources in R&D. On top of this, social and global challenges continue calling for more innovation as a solution. Ageing, the environment, and energy are good examples of challenges facing Japan which will require innovation in order to address them effectively. Finally, on the supply side, there are a number of opportunities in several industries such as information and communication technology (ICT), biotechnology, and cognitive sciences which could also help to deal with global challenges in the future.

Andrew W. WYCKOFF

This presentation will focus on opportunities which exist, particularly in the environment of the lingering economic crisis. Two OECD projects will be introduced and discussed. The first project regards knowledge-based capital (KBC) and the role of knowledge-based assets for growth. The second project focuses on measuring global value chains (GVCs) through trade in value added. Both of these projects' results are scheduled to be delivered at the 2013 OECD Ministerial Council Meeting (MCM), have their origin in Japan, and have attracted significant interest and attention from a wide range of countries.

KBC was originally referred to as "intangibles," although this word was deemed to be too academic and abstract for many policy makers. KBC is essentially assets which can be categorized into three broad groups: computerized information, innovative property, and economic competencies. Economic competency is the largest and most difficult group to understand and measure. It includes factors such as brand equity, firm-specific human capital, and organizational know-how. Although organizational know-how is difficult to measure, it is an extremely important factor in enterprise efficiency.

Investment in KBC has been growing dramatically over time, doubling in the United States over a 30-year period with almost the same numbers being reflected in Japan. In many cases, investment in KBC is larger than in tangible capital such as machinery, equipment, and structures. Intangibles such as software or data are causing dramatic growth in investment in KBC over time. This trend of a higher rate of KBC as opposed to tangible capital investment is occurring not only in the United States, but also in a whole host of other countries.

There are several factors to consider for the rapid growth in business investment in KBC. Rising educational attainment has resulted in more human capital available to exploit in comparison to the past. Globalization and deregulation trends have resulted in increased competition and innovation, which in turn means that KBC has come to have increased significance as a competitive advantage in firms. The wide diffusion of ICTs has allowed certain assets which already existed, such as data, to be captured much more easily and exploited as an asset for firms. This is a very recent phenomenon. Growth of the service sector has resulted in KBCs allowing for a competitive advantage and more productive business, as well as better manufacturing productivity. Finally, the domestic and international fragmentation of value chains means that organizations now have a much more specialized role, and KBC is what pulls together those value chains.

In terms of educational attainment, half of R&D expenditures go to wages. Therefore, R&D more or less constitutes human capital. Many products are becoming more knowledge intensive, and increasingly more automotive manufacturers view leadership in control software as vital. The automotive industry has changed in modern times such that approximately 40% of development costs in cars today are software and electronics related, which requires more knowledge-based skills than in the past. As an example, a high-end BMW now has seven microprocessors, three cameras, and several subscriber identity module (SIM) cards for communications abilities. Brands and design are other important areas in which educational attainment has had a positive effect on R&D and, in turn, KBC investment. The iPhone's design is part of what makes it such an attractive product, and ICTs have allowed for new aspects of retail sales to become much more knowledge-based than in the past.

In summary, the OECD is working on the policy-based implications of KBC. In terms of policy issues, it appears that policy framework conditions need to be redefined in terms of tax, competition, the legal framework for property rights, finance, skills, and corporate accounting. The reason for this is because many of these policies were designed with the notion of tangible capital in mind, and therefore they don't apply well to intangible capital. One example of this is in relation to finance. Most finance is revolved around debt and equity. KBC often requires a different kind of finance such as venture capital or angel-based. These kinds of finance operate by totally different rules and mechanisms to that of debt and equity. Tax implications for intangibles are very different from tangibles, partly because the former can be very easily moved around the globe by multinational corporations. This means that profit-seeking multinational corporations attempt to manage their profits around the globe and minimize tax payments. However, the assumption that subsidized firms which gain the benefit of R&D are usually domestic doesn't always hold true. In the case of KBC, multinational corporations often conduct R&D in one place, place the patents in a different place, and then produce in a third place in order to maximize the use of subsidies. This is why it is important to redefine framework conditions in relation to policy issues.

The rise of GVCs can be associated with the dispersion of production stages across countries and intra-firm trade, along with the development of networks of activities involving not only the movement of equipment or ideas but also people. This, in turn, has resulted in increased specialization, complex production relationships, and a rise in the global flow of goods. Case studies on large companies highlight this well. The Boeing Company has become less of a manufacturing company and more of a complex systems integrator over the years. Boeing airplane parts are produced all over the world and then assembled to create a very sophisticated product. The Renault Clio is another example highlighting the rise of GVCs. Its components are accumulated from all over the world, and the car is produced as part of a partnership between Renault and Nissan. A low-tech example of this is the Barbie doll, which continues to sell very well. The design and marketing knowledge-based processes take place in the United States, which are the driving forces behind the success of the product. However, assembly and materials come from various other countries. A final example of this is Apple Inc.'s iPod. Although it is known that the hardware is produced using an extended global chain, the related iTunes has now grown to become a platform not only for music but also for books, videos, and software. This is where the majority of the profit is made, and it also allows for a data stream of customer information. Customer purchases and clickstream information can be gathered by Apple and sold to publishers whose products are on iTunes. This is another example of the GVC being closely interconnected to KBC.

The OECD is researching a host of policy issues regarding GVCs. One such issue is that of the current measurement of trade. Multiple counting of intermediate goods and services results in the concealing of the actual patterns of trade, where the value is added, and who the beneficiaries of trade are. A different measure is required in order to portray accurately such information. This measure could be trade in value added (TiVA), which the OECD is currently developing. Objectives of TiVA would be to reduce multiple counting of intermediate goods and services and identify which countries and sectors contribute to the value chain in terms of income and employment. This research is being conducted in collaboration with the WTO along with the Institute of Developing Economies, Japan External Trade Organization (IDE-JETRO).

Early results on TiVA research on exported value added as a percentage of gross exports on several countries have shown a drop in all numbers between 1995 and 2009. The drop varies from country to country, though it clearly shows how GVCs have expanded. In 1995, there were three major regional value chains—North America, Europe, and Southeast Asia. In 2005, the Southeast Asian value chain vastly outgrew those in North America and Europe. With regard to products in value-added chains, around 75% of value added in the German automotive industry comes from Germany, however, a large amount of supply comes from other European nations. In Chinese electronics, only about 50% of the value added comes from China, with Japan being the major contributor outside of China. China's high-tech exports have grown between 1995 and 2005, however, the share of foreign value added has grown from 11% to 25%. Therefore, much of the growth has not been domestic but rather global. Finally, data on Japan's gross exports by region in 2009 show China and other Asian countries account for over half of all exports. However, in terms of value-added export partner share, the majority of it appears to go to Europe and the United States rather than Asia.

From the perspective of GVCs and national competitiveness, importing is becoming increasingly necessary in preparation for exporting. On top of this, a better understanding of the direct link between manufacturing and services is also developing. It seems that KBC is crucial in moving up the GVC, and value added can be gained through KBC at many points in the stream. Gaining value added at the production stage of the chain is more difficult but is still possible by strengthening technological capabilities in order to increase efficiency.

In summary, wide-ranging work on GVCs and KBC is being conducted across the OECD. Important milestones are approaching in February and March 2013, with the MCM taking place in May 2013. This is an ongoing stream of work which is expected to deepen and continue into 2014.

Q1: Are there any sector-specific implications in relation to the environment from your work?

Dominique GUELLEC
Possibly a result of the economic crisis has been to reduce the degree of the priority of environmental policies from agendas in all countries. It seems that employment has become the most important priority for Japan as well as other nations. However, environmental issues are still considered important, and the OECD has been doing work on environmental innovation.

Andrew W. WYCKOFF
The OECD has done research on green entrepreneurship start-ups, especially in relation to why it is important that the business model for an environment-related business is significantly different to that of other businesses.

Q2: I have a question regarding the relationship between KBC and R&D. We need to evaluate KBC as accurately as possible and invite investment in such activities. Does the OECD have a strategy to promote such activities?

Andrew W. WYCKOFF
One way to get more efficiency out of R&D is to look at complementary assets which make it more effective, such as KBC. The crisis has forced governments to prioritize looking at cost factors and efficiency. In terms of strategy, the OECD has started to put an actual figure on tax incentives for R&D for businesses. This has been found to be very costly, thus it may lead to changes in policy in the future.

Dominique GUELLEC
Since the economic crisis, many governments have been intervening in R&D policies. They are also starting to look at a broader picture regarding evaluation and intervention in terms of seeking more transparency and flexibility.

Q3: Another dimension of innovation other than economic growth should be for well-being. What are your opinions on this? Second, could you please elaborate on the trend for fragmentation mentioned in Andrew Wyckoff's presentation?

Andrew W. WYCKOFF
As innovation becomes more costly, there also comes an increased sophistication in products. Sharing those costs and the rise of specialization have caused fragmentation. Improved communication capabilities and decreased inconvenience of travel are other factors related to fragmentation. With regard to well-being, research on how to use innovation for the environment and ageing are also being conducted.

Q4: It was mentioned that policy agendas still have to adapt. Could you please elaborate on this?

Andrew W. WYCKOFF
Most of our knowledge is of networked industries of a tangible nature, but less so for new intangible platforms such data control. This has raised questions about whether our current competition policies are adequate for new digitally-based intangible network sectors. An example of this is that people are now using data mining techniques in order to perform free text analysis. This can lead to violating copyright laws. Intellectual property rights policies would have to be adjusted in order for this new type of innovation to exist.

Q5: What kind of policy option would you recommend in order to improve efficiency in the global chain at low expense?

Andrew W. WYCKOFF
At the moment, there isn't much leeway provided by governments, but one recommendation is to find a way for companies to improve the reporting and recognition of intangibles as assets. Another recommendation would be to secure a way for governments to release data and patents into the public domain.

Q6: It is very difficult to get R&D data, and in Japan, we have low response rates. How do you suggest coping with this problem?

Andrew W. WYCKOFF
This is a very common problem. The U.S. National Academy of Sciences has expressed the same problem of falling response rates, and has been openly discussing potential new sources to use in order to gather data. A final report on findings should be available by the end of the year.